Moore Stephens - Trusts & Tax Planning

Overview Trusts & Tax Planning Although the weather is finally changing for the better and green shoots are

appearing us,ofeconomically things are and stillshrouded very bleak and However, the out-deMany people all findaround the subject trusts & tax planning complex in mystery. spite these preconceptions the reality is that when you understand how they work, trusts can provide an look will remain wintery for some time to come. effective way to minimise your estate’s liability to tax and to protect your family’s interests.

What are Trusts used for?

The essential idea of Trusts is to protect a family’s long-term assets for future generations in a secure and controlled manner.

Assets held in a trust are not subject to probate unlike assets that are determined under your will. This means that, where appropriate, beneficiaries can have immediate access to capital or assets without having to wait until the executors have completed their responsibilities.

grandchildren in your lifetime or after your death. Skipping a generation in this way can reduce your own children’s exposure to tax.

Setting up a Trust When using trusts for tax planning you should take care that you use an appropriate trust for the particular purpose you intend and ensure that you understand the rules with regards to timing and the amounts of capital concerned.

Getting advice from a suitably qualified adviser should make this process straightforward.

Personal and Domestic Reasons

Trust structures enable the funds to be used for the benefit of family members or other beneficiaries such as Charities, without giving them direct control over the funds.

While trusts are often created for reasons other than tax, they can be used effectively for tax planning. This is particularly relevant where someone wants to reduce inheritance tax costs without passing funds into the direct ownership of children or grandchildren.

Trusts also retain an important role in providing for the maintenance and care of those unable to look after themselves, such as bereaved minors, the disabled and the elderly, not to mention the irresponsible and feckless.

Another of the key uses of Trusts is to protect your family home from assessment by the Local Authority against payment for Long Term Care so that you don’t join the estimated 100,000 people who have their homes sold to fund long term care every year.

Avoiding Taxation You can create a trust during your lifetime into which you place assets you no longer need. This will reduce your own wealth and can mitigate your own liability to Inheritance Tax (IHT) on your death. You could create a trust for your

worded to take account of the perceived risks surrounding the intended beneficiary.

Whilst many people use trusts as vehicles for tax avoidance, the majority of trusts have been set up to cater for family circumstances. For example, parents and grandparents may be concerned that children and grandchildren are at risk if they receive or inherit too much too soon.

A trust can be created to hold assets until the children are older, wiser and more experienced in dealing with money.

Alternatively, you may be concerned that if you leave all of your estate to your spouse, he or she may in turn leave insufficient capital to your children. A simple solution could be for a trust to be established for the surviving spouse, thus ensuring that the capital is protected without loss of financial security during the surviving spouse’s lifetime.

You might have an aged dependent that needs continuing care should you die before them. A trust can be created to hold sufficient capital to continue with that help and, on their subsequent death; the funds pass to your children.

Your son or daughter (or indeed their spouses) might risk bankruptcy, an unstable marriage or other unsuitable relationship, be handicapped and in need of special care, or for some other reason be incapable of managing their own financial affairs. In any of these situations, assets can be placed in a suitable trust vehicle carefully

A Trust is created by the transfer of legal ownership of a person’s assets to the control of a Trustee or Trustees, who will then manage the assets for the ultimate benefit of the chosen Beneficiaries. The person creating a Trust is known as the Settlor. The Settlor transfers legal title of specific assets (i.e. money, investments property or other assets) to the Trustees who must then hold and manage the assets in accordance with the terms of the Trust. These are set out in the ‘Trust Deed’ and the special duties imposed by law. Only the named Beneficiaries can benefit from income or ultimate ownership of the Trust assets.

The settlor will no longer own the legal title to the assets. Rather, they will be placed under the legal ownership of the trust itself, and will be dealt with by the trustees. However, there is nothing to stop the settlor from also appointing him or herself as a trustee.

The responsibilities of a trustee vary, depending on the nature of the trust itself. However, all trustees have a fundamental ‘duty of care’ to the beneficiaries. They must ensure that there is no conflict of interest between their duty to the trust and any other duties that they may have.

Where appropriate the trustees can transfer some of this responsibility by appointing suitably qualified investment managers who will take on the day to responsibility for managing the assets of the trust.

The trustees are obliged to act upon the explicit instructions of the trust deed and letter of wishes if one exists. In the case of a discretionary trust, however, the trustees will have considerably more freedom regarding their actions.

Modern trusts often give trustees wide ranging powers that can be used at the trustees’ discretion. How are these powers to be used? How can the trustees decide what the settlor wants them to do with the trust fund? A “letter of wishes” can help to guide them. Although not legally binding upon the trustees, a letter of wishes is a way for the settlor of a trust to inform the trustees of matters to be taken into account when those trustees are exercising their discretionary powers.

access to your capital if and when you need it.

The Origins of Trusts

This Trust may be suitable for individuals seeking to do some IHT planning but who do not want to completely give away access to their capital but provide them with a means of gradually giving away capital.

In general for the purposes of taxation, trusts settled by individuals during their lifetime fall into one of two categories: Absolute (or Bare) trusts and Discretionary (or Flexible) trusts.

The Settlor can demand repayment of the loan at any time and repayments are usually made by way of regular withdrawals (e.g. at 5% per annum). Any investment earnings on the Trust assets belong to the Trustees and are automatically outside of the Settlor’s estate for UK IHT tax purposes. Each payment made to the Settlor is considered to be a repayment of the original loan and as the value of the outstanding loan gradually diminishes so the value of capital transferred out of the estate for IHT purposes increases.

Trusts were first established back in the Middle Ages by crusading knights who were, for the most part, wealthy noblemen.

They would leave their various and extensive possessions in the hands of ‘Trustees’ – trusted friends or senior members of the church that they felt able to rely on to protect their worldly goods. In the unfortunate event that a knight failed to return, their assets would be dealt with by their ‘Trustees’ in accordance with their stated wishes recorded before they left.

Discretionary Gift Trust A Discretionary Gift Trust, as its name implies, can be an excellent choice if you are in a position to gift your assets, without needing access to them in the future.

A possible solution for IHT purposes, the Gift Trust allows the settlor to give away wealth that will not be needed in the future. The assets held within this trust have the added benefit of being outside the settlor’s estate for IHT purposes after seven years, with investment earnings on those assets being outside the estate immediately.

By virtue of being a trustee, a settlor can still have an influence over decisions related to the trust assets.

A trust is established and the Settlor then lends an amount of capital to the Trustees interest free. The Trustees then invest the loan.

Life Interest Trust This is a trust where one person, the ‘life tenant’, has a right to income for life or for a fixed period, and others, the ‘remaindermen’, are entitled to the capital on the death of the life tenant or on the expiry of the trust period.

This concept lives on in the modern day and is governed by continually developing “Investors are increasingly turnlegislation. It is the separation of the legal ing to real assets totheprotect ownership of assets from potentialthe to enjoy the benefits of them that provides the buying pow­er of their capital.” basis of modern Trust law.

What Are Trusts Used for?

A trust might be created in various circumstances, for example: •

When someone is too young to handle their affairs

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When someone can’t handle their affairs because they are incapacitated

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To pass on money or property while you are still alive

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Under the terms of a will - referred to as a ‘will trust’

Importantly, with the Gift Trust, the settlor is not permitted to be a beneficiary.

A Glossary Of Trust Terms Discretionary Loan Trust A Discretionary Loan Trust, in contrast to the Discretionary Gift Trust, is an ideal way to establish effective UK Inheritance Tax (IHT) planning but without giving up the ability to enjoy

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Settlor - The individual who establishes the Trust

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Trustee – One or more persons respon-

sibleare for managing the Trust “We concerned thatassets pros-

pects for corporate bonds are

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Trust Deed - The legal document that

notsets asout strong asTrust they once were how the assets are to be managed and as such we have reduced

allocation.”

•our Beneficiaries - One or more persons who may ultimately benefit from the Trust assets •

Letter of Wishes – Settlors Instructions on how the assets are to be managed and distributed

Discretionary Trusts

Spousal Bypass Trusts

A Discretionary Trust has a range of potential beneficiaries defined at outset and the trustees are given the discretion to advance income and/or assets (or not) to any of the beneficiaries. The trustees can add new beneficiaries and have a great deal of flexibility in deciding how the trust will operate and for who’s benefit.

A simple trust based solution that could, in the event of your untimely death, enable you to provide for your spouse, pass on pension benefits to the next generation and protect your estate against a substantial Inheritance Tax charge.

The Trustees may also have discretion about how to distribute the trust’s capital. In many such trusts they can also accumulate income.

This type of trust may be subject to an initial lifetime IHT charge where the amount gifted by the settlor exceeds the Nil Rate Band. 10 year periodic tax charges and exit charges could also apply and careful planning is needed as a result before these trusts are established and assets are gifted.

Absolute Trusts When you are certain about who you wish to benefit from a trust and there is no doubt, you may wish to consider an absolute trust, also known as a bare trust.

It is important to note that once this trust is set up, the beneficiaries cannot be changed.

You must be certain. The money inside this trust cannot ever be claimed back by you and can be demanded by the beneficiaries at age 18.

The benefits paid on death from most pension schemes (and from some life insurance policies) do not normally form part of your estate (for inheritance tax purposes) as the pension scheme trustees hold them in trust for you. If you have not told them otherwise, the pension trustees will usually pay the death benefits to your spouse outright.

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Parents or grandparents who wish to put lump sums of money in trust for their children Parents or grandparents who wish to put potential life insurance pay outs on death in trust for their children Couples who wish to put potential life insurance pay outs on death in trust for each other Settlors (the person making the gift) who wish to avoid the periodic or exit tax charges

Additionally, if your spouse requires long-term care then the funds held in the trust will not be assessed as part of any means test.

A Spousal Bypass Trust can also be nominated as the recipient of any payment made from a death in service benefit and may also be suitable to hold the proceeds of a life policy.

While this might seem an attractive option, it has the effect of putting a lump sum of cash into the hands of your spouse, which could then be assessable for the payment of longterm care fees and inheritance tax.

The trust is tailor-made to your particular circumstances: you decide whom you wish to appoint as the trustees and also decide whom you wish to be the beneficiaries.

An alternative option is to have the benefits paid on death to a discretionary trust and thereby bypass the estate of your spouse. Setting up a spousal bypass trust and transferring death benefits to it does not mean that your spouse is unable to access the funds in the trust. The beneficiaries of the trust would include the surviving spouse together with children or anyone else you choose to nominate.

Whilst the surviving spouse is alive, it is usual for them to be treated as the primary beneficiary of the trust in order that the trust fund can be used to maintain their existing lifestyle without the resulting IHT liability.

This type of trust is not subject to the 10year periodic tax and exit charge rules that most other trusts are subject to.

This type of trust may be suitable for:

Your spouse could choose to take interest free loans from the trust instead of drawing capital. This would be beneficial since these loans would have to be repaid to the trust on the death of your spouse thereby helping to reduce the value of their remaining estate for inheritance tax purposes and allow you both to pass on more to your children or anyone else you choose as beneficiaries.

Deceased Spouse Pension and Life Insurance Benefits

Once you have established the trust, you complete a nomination form in which you request that your pension administrators pay any death benefit to the trustees.

It is also advisable to prepare a letter of wishes to provide guidance to the trustees. The letter might suggest the circumstances in which you would wish the trustees to consider making a distribution and the factors they might take into account.

Alter nativ e Rou Deat te fo h Ben r efit P ayme nt Spousal Bypass Trust

Traditional Route For Death Benefit Payment

Surviving Spouse’s Estate Liable For Inheritance Tax

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Assets Pass To Beneficiaries Free Of Inheritance Tax

Eventual Beneficiaries Children, Grandchildren Or Others

Discounted Gift Trusts TRUSTEES A trust based investment solution that allows you to reduce or eliminate your Inheritance Tax liability by passing on capital to your children, or other beneficiaries,

Manage the trust assets in accordance with the trust deed and letter of wishes

Putting It All Together

SETTLOR Establishes a trust by gifting a capital sum into the trust

Capital

Capital gifted (less any discount) is outside the settlor’s estate after 7 years

Gift

BENEFICIARIES Residual Capital

The settlor is entitled to receive an “income”for life. This is typically taken at 5% pa

Entitled to benefit from the trust proceeds upon the death of the Settlor

Income for life drawn by Settlor

Discounted Gift Trust

Exempt Transfer, depending on the version of the trust used) and will fall out of the settlor’s

With bank and building society interest rates at all time lows, savers are struggling to achieve anywhere near reasonable rates of return. At the same time many of them face significant Inheritance Tax (IHT) liabilities upon death with the taxman taking 40% of all estate capital above the Nil Rate Band (NRB), which is currently set at £325,000 per person.

estate after 7 years. The remainder, representing their retained rights, is outside of their estate immediately.

A Discounted Gift Trust could offer individuals, or couples, a means of; •

Boosting their investment returns

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Reducing their liability to IHT

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Generating an income for life

How Does It Work?

In simple terms, the DGT is established either by investing directly into an investment bond which is then placed in trust or by placing cash into a trust for trustees to invest into the bond.

Under the DGT arrangement, the settlor has an entitlement to a series of regular payments, of a specified amount, determined at outset. It is quite common for these payments to be 5% of the original capital each year (in order to tie in with the 5% tax deferred allowance for bonds) but the payments can theoretically be of any amount.

What Is A Discounted Gift Trust?

It is clear that the best way to avoid a liability to Inheritance Tax is to die with assets below the NRB and that one good way to accomplish this is to give away assets while you are alive (and then survive for seven years!). The problem with this is that many people rely on those assets to produce an income for them during retirement and this income would have to stop should they give their assets away.

A Discounted Gift Trust (DGT) offers a means for clients (termed settlors when establishing a trust) to transfer significant assets into a trust, to be held for the benefit of their chosen beneficiaries, whilst at the same time retaining a right to benefit from an “income” from the trust for the remainder of their life.

Importantly, an element of the transfer will be regarded as a gift for IHT purposes (either a Chargeable Lifetime Transfer or a Potentially

These regular payments will be paid to the settlor on pre-selected dates subject to him or her being alive, and provided the trustees have sufficient funds remaining to make the payments when they fall due.

The fund representing the settlor’s retained rights is not a gift for IHT purposes, since it represents the amount that the settlor expects to receive back during his or her lifetime. As this amount is not given away, it is therefore deducted from the total amount placed into the trust and is known as the ‘discount’.

The remainder of the trust, not to be used for the settlor’s entitlement, is held on trust – either a discretionary or absolute version – for the benefit of the settlor’s family or other chosen beneficiaries.

In summary, the DGT allows settlors to place a capital sum into an investment bond, which will then allow them to generate an income for life (5% pa normally).

The bond is in turn placed within the trust and depending upon their circumstances, the settlors may receive an immediate discount for IHT purposes. The remaining non-discounted capital within the bond will be considered to have left the settlors estate when 7 years have elapsed. At this point, the capital value of the monies contained within the bond is outside of the settlors estate and is held in trust for the beneficiaries nominated by the settlor who continues to enjoy the income stream the DGT generates for the remainder of their life. Ultimately, upon the death of the settlor, the capital in the DGT reverts to the beneficiaries who may then choose to bring the trust to an end or continue with it depending upon their needs.

Key Points

Charitable Trusts

Tax Benefits

Creates a lasting legacy that continues to do good, year after year .

The trust will be able to take advantage of many tax benefits. Apart from the tax relief on your own donations to the trust, it will not pay tax on its investment income or capital gains. It will not pay corporation tax or inheritance tax.

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Avoids Inheritance Tax

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Avoids 55% Pensions Tax Charge

Taxes on death can be substantial. Having to pay Inheritance Tax at 40% and as much as 55% Tax on pension funds is an inefficient way to pass on capital. Alternatively, setting up your own charitable trust allows you to create your own lasting legacy that can continue in perpetuity after your death continually supporting causes that are important to you.

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Qualifies for Gift Aid & Payroll Giving

Setting Up Your Own Charitable Trust

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Exempt from Income Tax & Capital Gains Tax

A charitable trust or foundation is a legal organisation which can be set up by anyone who has decided that they want to set aside some of their assets or income for charitable causes.

The trust is governed by a trust deed that includes the charitable purposes that the trust will work within. These can cover many different areas including; poverty relief, education, animal welfare, the arts, environmental welfare and many others.

Considerable Tax benefits are available.

You do not need a large amount of money to set up a personal charitable trust.

Family and friends can contribute or act as trustees.

The charitable purposes must be for public benefit, such as;

You do not require a large amount of money to •

Poverty Relief

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Advancement of Education, Religion, Amateur Sport

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Advancement of Human Rights, Environmental Issues

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Advancement of The Arts and Animal Welfare

set up a simple personal charitable trust. Quite often, the first endowment is a lump sum from a bonus, an inheritance or the sale of shares.

But because a charitable trust is a charity, it can receive money tax-free from inheritances of estates or pension schemes. It can also receive funds from individuals using Gift Aid or payroll giving. A charitable trust may be suitable if you want to give capital as a one off or on a regular basis, or if you want to ask others to contribute to the trust’s funds.

What are the advantages?

Setting up your own trust provides a framework for planning your charitable giving in a systematic and thoughtful way. It will also give you a greater say in how the money you give is directed to the causes you want to support.

You can choose what to call your trust, so it can carry your family name or that of someone you want to honour, or be totally anonymous.

By giving it a personal name, you can give your charitable giving an identity, which can be as flexible as you want. You don’t have to include the word ‘trust’ in the title. You can call it a ‘foundation’ or ‘charity’ or any similar term.

Many people involve their family, or friends and colleagues, as trustees and find it an enjoyable and constructive way of developing a shared commitment to giving.

You and the other trustees can decide independently exactly how much you would like each beneficiary to receive. It is simple for them and for you. Your main responsibility is to work within the charitable purposes and the powers set out in the trust deed that governs the trust.

Gift Aid is a particularly efficient means of donating to your charity once you have established it. For example, lets assume that the donor is a basic rate tax payer and wants to donate £1000. Under Gift Aid, the charity can claim back £250 on the donation. This is because the ‘gross’ amount of the gift is considered to be £1,250.

However, if the donor is a higher-rate taxpayer, they are entitled to claim the difference between the basic rate (20%) and the higher rate (40%) on the total value of their donation (the ‘gross’ amount), which they can claim through their tax return. Assuming a £1000 donation, the charity will receive £1,250 and the higherrate taxpayer can claim back £250 meaning the net cost to them is £750. For 50% taxpayers (i.e. those earning more than £150,000 per annum) the position is even better. A £1,000 donation is grossed up to £1,250 for the charity and the 50% taxpayer claims back £375 meaning that the gross donation of £1,250 has only cost them £625.

Supervision The only outside supervision comes from the Charity Commission for England and Wales.

Once the trust has been registered it must publish a formal annual report and accounts which should include a list of any grants made to organisations and report any significant changes to the trust. These reports are sent to the Commission each year. This involves some paperwork but is generally not a huge burden.

As long as the trust stays within its own rules and is properly administered, the regulators generally cannot tell the trustees what to do.

The trust can continue after your death, and may be the beneficiary of a legacy from your estate which will also be tax-free. The trustees will continue to distribute funds according to the guidelines set out in your constitution. This way you can make sure that your favourite causes continue to benefit.

How does it work?

There are several ways of setting up a trust, but the basic model needs: •

A donor or ‘settlor’ (which may be you, your family or business);

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Trustees (who could be you and members of your family, as well as someone outside the family such as your lawyer or a family friend);

Within the charitable purposes, a trust can help organisations or individuals. It can operate anywhere in the world unless you have decided in your charitable purposes to restrict it to the UK or a particular geographical area.

Charitable purposes (which set out the type of causes the trust can support); and

The trust deed is the constitution of the charitable trust. It sets out the framework within which the trustees must operate. Apart from describing the charitable purposes the trust has been set up for (which can be general), a trust deed will generally describe:

A trust deed (which forms the trust’s constitution).

The trustees hold and control the trust’s assets. They decide how the income and capital (assets) of the trust should be distributed, and make sure that this is in line with the charitable purposes of the trust.

The charitable purposes, or aims, form part of the trust deed and describe the sort of causes that the trust can support. These can be worded in quite a general way so the trustees can keep their options open and allow the areas of interest to develop over time, or they can be very specific to ensure that the funds are distributed for the purpose intended by the

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The powers and responsibilities of the trustees;

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How they are appointed and removed;

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The approach to investment;

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How the constitution (but usually not the charitable purposes) can be altered; and

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What will happen after the death of the settlor.

donor.

Setting up a charitable trust can be very rewarding and relatively easy. It will need some effort and help at the start but the on-going running costs (which are not generally high) can be paid out of the trust’s own income.

By law the charitable purposes must be for public benefit as per the definitions that the law regards as charitable, which include relieving poverty, promoting education or religion, or helping the community in many other ways.

Pension Fund Residual Values can be paid to the trust avoiding a 55% Tax charge

Gift Aid Payments

ents

Paym

Capital left through a will is paid to the trust without Inheritance Tax

Paym

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ents

In

Trustee Trustee

Trustee

Trustees manage the assets of the charitable trust taking account of the settlors wishes and supporting those charities and causes specified whilst seeking to maintain the long term value of its assets

Paym

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Out

Regular distributions to charities, individuals or causes of your choice

ents

Paym

Out

Special one-off grants or payments made at the discretion of the trustees

Payments made by other family members, friends or payroll giving

The Next Step To find out more about setting up your own charitable trust, please get in touch with us using the contact details overleaf, or via your usual Moore Stephens contact.

We offer all prospective clients a free initial meeting to discuss your requirements.

The reason we don’t make a charge for this first meeting is because it is an opportunity for you to decide whether or not you wish to use our services. We will explain how we can help you and the cost of our services for carrying out any work on your behalf. If you decide you want to proceed, we then will gather information from you about your current finances, your income and outgoings, and your plans for the future.

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www.msfs.co.uk This document is provided for information purposes only and does not constitute any form of financial or investment advice. Past performance is not a guide to future investment performance. The value of your investments as well as any income derived from them can fall as well as rise and you could get back less than the amount invested. We believe the information in this brochure to be correct at the time of going to press and is based on our current understanding of legislation and tax allowances which may change in the future. As such changes can’t be foreseen we cannot accept responsibility for any loss accessioned to any person as a result of action or refraining from action of any item herein. Printed and published by Moore Stephens Financial Services (East Midlands) Limited. Authorised and regulated by the Financial Services Authority.

January 2011